One of the features of the credit crunch era has been something that would not have been expected beforehand which is that house prices in more than a few countries are running hot. If you think about it house prices should have fallen in response to the credit crunch as banks and economies retrenched and wages fell as I was discussing only yesterday. But something else was thrown into the mix which was the monetary easing of central banks where interest-rates were cut and plunged us into the ZIRP or Zero Interest Rate Policy era. This has been followed in the last year or so by NIRP as some countries have taken the policy interest-rate negative.
Also we have seen a range of extraordinary monetary policies such as Quantitative Easing which in the UK is being kept at £375 billion. Also if we look at the UK experience the Funding for Lending Scheme began in the summer of 2012 and look what even Jon Cunliffe of the Bank of England thinks happened next and the emphasis is mine.
But over the past three years, as banks’ funding costs have reduced and as competition in the mortgage market has intensified, on average mortgage interest rates have fallen by 2 percentage points.
We learned only on Tuesday the impact of that on house prices in the UK.
UK average house prices increased by 6.1% over the year to September 2015, up from 5.5% in the year to August 2015
Now as the economy has been in a recovery phase for a bit you might think that such a situation is okay but then you have to address this.
In September 2015, the UK mix-adjusted house price index increased 0.3% from the previous record level witnessed in August 2015 to reach a new record of 219.8 (Figure 2). The UK index is 18.5% higher than the pre-economic downturn peak of 185.5 in January 2008.
This has been driven but the cuts in official interest-rates which were followed by moves to push mortgage interest-rates even lower and the moves went on and on until house prices were driven higher. After all it wasn’t real wage growth was it?
However earlier this month Nemat Shafik of the Bank of England told BBC radio this.
Interest rates ‘not tool for housing market’
There is the obvious issue that since 2008 the Bank of England has been doing exactly that! Perhaps the ability to overlook such things was not only a factor in her being parachuted in as a Deputy Governor but also in the award of a Dame hood in June. Also as she is one of those who keeps telling us that the Bank of England is about to raise interest-rates why not simply let them that part of their job?
Dame Shafik has an alternative for house prices
It has tools to do things like put limits on the amount of indebtedness that households can take on, it can reduce banks’ ability to lend very risky loans, so for us we need to use the right tools for the right problem.
Okay but perhaps as she sits at the next meeting she could tell Jon Cunliffe who told us a different story.
I do not think that the role of the macroprudential authority should be to control asset prices including house prices.
It reminds me of one stage of the UK desert campaign in the second world war which came under the category “order,counter-order, disorder”.
Back in the day this used to be called credit controls many of whom we scrapped back in 1979 when exchange controls were ended and we moved away from such policies. The problem back then was the economy was jerked forwards and backwards and indeed distorted as institutions moved to get around and subvert restrictions which were then changed. It was not a triumph although advocates of what is called macropru often ignore that.
In the UK we have seen an example of it when the Bank of England introduced MMR or the Mortgage Market Review in April 2014. This tightened the rules for lending at high income multiples and ended self-certification mortgages which had acquired the rather descriptive title of “liar loans”. There was an obvious initial issue for some as described by Mortgage Strategy.
The biggest problem created by the MMR has been mortgage prisoners. These are borrowers who took out a mortgage when affordability rules were more relaxed and are now unable to get a deal in the new environment.
How are things going?Not so well according to the Guardian at the end of October.
Sub-prime mortgages, widely blamed for causing the 2007-08 financial crisis, are making a surprise comeback in the UK, with several new lenders launching home loans for people with poor credit histories.
This bit raised a wry smile.
Matt Andrews, managing director of Bluestone Mortgages, said: “We don’t like the term sub-prime – it implies these customers are somehow inferior to prime borrowers, which they are not.
We see above two of the fundamental problems of macropru which happened in the past. One group is disadvantaged in getting credit and at the other end of the spectrum we see lenders getting around the rules and a group who not so long ago we decided shouldn’t have such easy access to credit get back in the game.
Bank of England research
A paper released this morning offers some insights into the problems of macropru.
But the effectiveness of these instruments may be compromised if banks and borrowers are able to avoid these measures via regulatory arbitrage or if the regulation is subject to `leakages’ whereby the activity migrates to institutions which are not covered by the instruments.
Those 43 words used to be covered by just one disintermediation. One issue may have been noted above as you see several of the subprime lenders above are Australian institutions.
Some macroprudential instruments – in the absence of reciprocal arrangements – cannot be applied to all financial institutions within a country.
Also there are issues with another sector which we have not heard mentioned for a while.
Much of the debate over leakages has focused on lending by ’shadow banks’ or non-bank financial institutions,
You will not be surprised to read that the paper comes out in favour of macropru overall as it would be quite an own goal otherwise. A literal personal one in a way as one of the authors works for the Macroprudential Strategy and Support Division at the Bank of England.
This is another issue for our valiant regulators as we have the issue of whether such policies are applied at the right time or whether they are always too late? We are seeing an example of this in Sweden right now where there is a house price boom which I would argue is a bubble and yet the Riksbank Minutes tell us that little has actually been done about it.
several members of the Executive Board again emphasised that there is a great need to promptly clarify mandates and tools within the area of macroprudential policy and to adopt measures to manage risks on the housing market and risks linked to household debt.
We are left with the impression that central bankers rather like the idea of the boom happening and then arriving too late like General Terry at the battle of Little Bighorn.
The problems with macropru described above are known so I can only conclude that central bankers are trying to redact them from history. As I have already pointed out this is especially odd in the UK as according to Forward Guidance rises in interest-rates are supposed to be on their way. The hints are by now familiar “at the turn of the year” “sooner rather than later”.
There is another oddity because you see the Bank of England still has its foot on the mortgage market pedal via the Funding for Lending Scheme.
During the second quarter of 2015, the number of groups participating in the FLS Extension was 34. Of these, 11 participants made drawdowns of £5.1bn in total. Participants also repaid £0.9bn, taking total outstanding drawings to £61.4bn.
This is supposed to be for small business lending these days but then of course it always was! Let us be nice and say it has flatlined but what about mortgage lending? From the BBC last week.
The CML said that gross mortgage lending totalled £61.4bn in the third quarter of the year. This was up 18% on the previous quarter and a 12% rise on the third quarter of 2014.
Oh and I do hope that the lending to small businesses is not a form of corporate buy to let funding. Oh buy to let! Surely that is not yet another hole in the net of our valiant macropru regulators?
So the answer to my question is no. At the moment that is because they do not want it to. Should they apply it the side-effects would quickly be so great it would be rapidly watered down or kicked into the long grass (assuming there is still some space in that crowded area). But they could at least claim to have done something…..